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Monday, July 10, 2017

Leading the Reform

According to an
article in last week’s Wall Street
Journal, “America Once Led the World on Tax Reform” (07/06/17, A15),
America once, er, led the world on tax reform.This is actually kind of meaningless, because what the author of the
piece talked about was the fiddling with the Internal Revenue Code under
President Reagan, not the more fundamental issues addressed by the Continental
Congress under President (of the Continental Congress) John Hancock.

John Hancock, Fourth President of Congress

As you might
expect from the Wall Street Journal, “tax
reform” seems to be defined as something that allows a corporation to
accumulate earnings instead of paying the money out to shareholders in the form
of dividends so the corporation can use the cash for expansion.This way the corporation avoids the
possibility that if it had to sell newly issued shares to finance expansion
nobody would buy them . . . because the corporation doesn’t pay dividends. . .
.

No, it’s
true.People used to invest in corporate
equity to get dividends!This is not a
myth.An investor got a little pile of
money, and put it into something that would generate a steady stream of
income.He or she could then do whatever
he or she wanted.

Then Henry Ford
decided that he would finance an expansion of the Ford Motor Company by
retaining earnings instead of borrowing money or issuing new shares, and cut
the dividend rate.Borrowing money would
have kept ownership concentrated, but put the company in danger from the Jews
who (so Ford believed) controlled the banks and were trying to take over the
world.Not like the Catholics, who controlled
the lower ranks of the army and politics and were trying to take over the
world.Or the British, who controlled
the banks, politics, and the army and had
taken over the world. . . .

Henry Ford, American Plutocrat

Ford’s decision
annoyed the Dodge brothers, who controlled the second largest block of shares,
and who had been banging their heads against the wall for years trying to have
some input into management decisions, including automobile design.Now Ford was taking away their income . . .
do you suppose he had gotten wind of their idea to use their Ford dividends to
start up their own automobile company so that they could design the cars they
wanted without Henry simply saying “no” to everything?

So the Dodge
brothers sued for non-payment of dividends.The Michigan Supreme Court invoked the new “Business Judgment Rule” that
effectively said if you don’t own the majority of the shares, you don’t own
anything.Henry Ford could do as he
pleased because he had the majority of the shares.Furthermore, he could even force the Dodge
brothers to sell him their shares at the price he set if they didn’t like the
way things were run.

1926 Dodge sedan: the car that killed the Model T Ford

Beaten, the Dodge
brothers went and set up their own company anyway, and developed what many
automobile aficionados still consider the best popular automobile ever made:
the 1926 Dodge.Sales of the Ford Model
T plummeted.Ford shut down all Ford
factories, designed the Model A, retooled, and reopened . . . having lost a huge
share of the market.He lost millions,
possibly billions, but (like Frank Sinatra) he did it his way.

Thus, financing
expansion out of retained earnings (or, more usually, using retained earnings
for collateral for bank loans, since the cash was tied up in plant and
equipment) instead of selling shares became the way to grow.Ownership began to be concentrated, then
super concentrated.

Further, the tax
system had to be adjusted so that companies would have enough money built up so
they could grow.The tax system,
especially a few years later during the New Deal, shifted from the job of
providing funding for government, to social engineering.The Federal Reserve shifted from providing
money for the private sector, to funding government . . . and you wonder why
the debt is so high?That’s what happens
when you hand the politicians the key to the money machine.

Adam Smith: Four principles of taxation

That’s why before
you can talk about specifics of tax reform, you have to talk about principles
of tax reform, and these days you can’t talk about tax reform at all unless you
talk about monetary reform.So what are
the basic principles of tax reform? As listed by Adam Smith:

·Equity:
All people should pay taxes in proportion to their ability to pay.

·Certainty:
Taxes should be certain and not arbitrary.

·Convenience:
Taxes should be levied in a manner and at the time most convenient for the
taxpayer.

·Efficiency:
The cost of tax collections should be as low as possible to yield the maximum
benefit to the public treasury.

Obviously, none
of these principles is in effect today.Equity?Tax policy is to exempt
the rich because they are presumably the only source of financing for new
capital.Certainty?How much tax you pay depends on how well you
know the tax code and can game the system.Convenience?So-called estimates
of time and money to file and pay your taxes are a joke.Most people need professional help to figure
out how and how much to pay.Efficiency?And what is the
budget of the IRS?

No, the
principles of taxation are a dead letter to all intents and purposes.What should the tax system look like?

Why not raise the
personal exemption to, say $30,000 for non-dependents and $20,000 for
dependents, eliminate all other deductions, credits, and so on, and have a
lifetime tax deferral for money used to purchase capital assets that generate
income up to an accumulation of $1 million?

For corporate
taxation, why not raise the corporate tax rate to, say, 75% . . . but make
dividends tax deductible at the corporate level, but fully taxable as ordinary
income at the personal level . . . unless used to purchase newly issued,
dividend paying shares by means of which corporations can finance growth
instead of retaining earnings and not paying dividends?Every corporation could escape all income
taxes simply by paying out all earnings as dividends.